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Douglas Irwin on Free Trade, the Gold Standard, and American Economic History
Slow growth and increasing automation has made trade more politically divisive than ever.
Doug Irwin is a Professor of Economics at Dartmouth College, a research associate with a National Bureau of Economic Research and a former staff member of the President's Council of Economic Advisors. Doug also served as an economist at the Federal Reserve Board of Governors. Doug joins David on the podcast to discuss the economic arguments for free trade, the impact of Chinese economy on U.S. manufacturing and labor markets, and the role of the inter-war gold standard during the Great Depression.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Doug, welcome to the show.
Douglas Irwin: Thanks for having me, it's a pleasure.
Beckworth: Okay. Well let's begin by asking how did you get into economics and specifically into trade economics?
Irwin: Well, I grew up in a small town in the pre-internet era and I was always interested in the outside world. So I started listening to shortwave radio and following world events. I always wanted to travel and see the world. And that groomed me into the economic interactions between countries in terms of trade. I guess I should also mention my father was an economist, so I sort of naturally went into economics.
Beckworth: Oh, really?
Irwin: I resisted it for a while and tried to go into political science, but I realized so much of political science depends on what's going on with the economy, that I was sucked into economics.
Beckworth: Okay. Now, how did you pick trade over, say, macro or some other field in economics?
Irwin: Well, I was interested in international economics in particular and how countries interacted. I studied both the international monetary finance side and also the trade side, but I've always been interested in trade policy. And I guess when I was an undergrad in the early 1980s, there was a lot of discussion of protectionism. This was the Reagan administration and we had the VERs on voluntary export restraints, on autos, we were protecting the seal industry, so it was very much in the news. I think I was drawn to it that way.
Beckworth: Okay. Well, let's talk about trade. Let's begin by going over what are the main arguments for it. Now trade is generally viewed by economists as a net win for society. If you go look at the top economists that have been polled by the University of Chicago, the IGM forum, close to 90% support free trade. Similar numbers believe that NAFTA has been good for the average American. Why do economists generally favor free trade? What are the main arguments for it?
Irwin: Well, for your readers of my book, “Free Trade Under Fire,” which goes through this quite a bit, just to summarize, I'd say just as we as individuals gain from specialization and exchange, we generally don't make our own food. We don't make our own clothes. We specialize in one activity and then buy the range of goods that's available on the market. Just as individuals came from specialization and trade, so do countries. Countries take advantage of their different resources and try to manage those resources as best they can to purchase what they can on the world market and gain that way. So really, it goes back to Adam Smith, who talked about this process very eloquently and I think his writings are still pertinent today.
Beckworth: Yeah. No. We generally say as economists that there will be winners and losers. There are distributional issues, but on balance, it's a net gain for an economy. Is that correct?
Irwin: That's right, yeah. There's always been distributional consequences. When we think about certain big historical movements in trade policy, like Britain repealing corn laws, that sparked a huge debate in Britain in the 1830s and 1840s. It was clear that farmers and landowners were going to be worse off, but it was thought that workers and laborers and others would be better off from having free trade in wheat, at the time.
Beckworth: Okay. Trade is generally endorsed as a good thing by economists. But lately, it's been taking something of a beating. In particular, here in the U.S., the presidential election, I think it's gotten a black eye. On the Republican side, Donald Trump has taken a very strident stand against the kind of trade the economists support. He's said many times that trade is killing us. If you look at the GOP platform from the convention, it actually mentioned trade deficits as a problem, as compared to previous GOP conventions where it wasn't a problem and trade deficits were actually bigger.
Beckworth: On the Democratic side, Bernie Sanders has been pushing also his own concerns about trade. Even Hillary Clinton, who in the past has been favorable toward trade partnerships, the TPP is now a little less enthusiastic about it. The Wall Street Journal reporter, Greg Ip, called this, Political Backlash in the U.S., the Rise of Zero Sum Economics. We have this pushback we see in U.S. politics, at least during the election time. What's behind that do you think? Is it really trade? Is it something else going on? I ask that because you've written an article recently in Foreign Affairs, where you address this question. What did you argue in there?
Irwin: Well, I think it's actually, well I guess I'd point to two things. One, the backdrop is we've had fairly weak economy since the early 2000s. This is something I know you discussed on your podcast with Scott Sumner and others about nominal GDP growth being low, what's the role of the monetary policy? But whenever you have a robust growing economy that's creating jobs, it makes transitions between jobs easier. So when there are structural shifts or trade shocks, it's much easier to manage those, and there's less political fallout when the economy's doing well. We just haven't had that for some time.
Irwin: I think slow growth has really made trade much more of a divisive issue, much more of a zero sum attitude among many people. We don't see the gains. And when you add on top of that, that we are going through this structural shift where we have much greater technological change in automation and manufacturing, so blue collar workers find they have fewer job opportunities, that just compounds things.
Irwin: Then a broader issue too that seems to be affecting not just the United States but also Europe and certainly in UK with Brexit is this cultural aspect of things in terms of openness versus closedness, national versus international, cosmopolitan versus local or however you want to slice it. But one of the interesting parallels between the Brexit debate in the UK and the current U.S. debate over trade is that it's not really a left/right issue. Both political parties are going through this internal debate, if you will, on our trade policy. Just mentioned that the Republicans are divided on this. Certainly Democrats have moved stronger anti-trade with Sanders and what have you. But we also see this in Britain with Brexit labor parties being torn apart. It's not just the conservatives.
Irwin: So I don't know if we're really seeing a transformation from a left political divide to an open/close, but certainly it's not really clear cut across the different parties how they're approaching this.
Beckworth: Yes. There's been several polls out. I saw you link to one on Twitter. There's a Wall Street Journal NBC News poll, there's a Third Wave poll that shows that a majority of Americans still support trade even if there is more economic angst.
Irwin: Right. Actually the numbers change a little bit over time. But oddly speaking, in the United States, people don't have a big problem with trade. Now there's certainly a 1/3 that are staunchly anti-NAFTA, think trade has really harmed the United States, but you're seeing the majority or a little bit more see trade as an opportunity rather than a threat.
Irwin: I point to these frequently because there's this narrative among journalists and others that whether there's this anti-globalization backlash. I think we really have to separate out different elements of globalization. There are four that one can point to.
Irwin: One is trade in goods. The other is capital flows from countries. A third would be labor migration between countries, immigration/emigration. And a fourth would be political efforts to achieve an economic union or political union or something like that. So there are different ways in which countries can integrate.
Irwin: Trade is the first one and also the least controversial. No one in UK was really complaining about, "Should we want to cut back our trade on Europe?" It was really had to do with labor migration and political union. And the same with the United States, there was a great deal of concern about immigration, but I think there's much less concern about trading goods, per se.
Beckworth: Okay. You mentioned earlier that part of the reason for the pushback against trade is simply that growth has not been very robust. The recovery since the great recession hasn't been typical. It's been sluggish. There's lots of arguments for that. We won't get into those. I have my strong views on that.
Beckworth: But similarly, you take that argument, doesn't it apply to Europe as well? The UK? Had Europe had a more robust recovery, that would've spilled over to the UK. And had UK had a more robust recovery, some of these concerns about trade would definitely be softened. Is that correct?
Irwin: Absolutely. If you look at past decades, when there was a lot of trade liberalization taking place, it was relatively uncontroversial because a lot of jobs were being created, a lot of economic opportunities for those who were going to be adversely affected. You had evolution economy in terms of shocks that played out over many years rather than big, short term shocks like a big recession or a big surge in imports or things like that.
Beckworth: Okay. That leads me to wonder that if you were to look at the data, if they had this polling data, do you find an uptick in this type of sentiment every time there's a recession or some kind of economic stress, because people can easily turn to immigrants to treat as scapegoats? Has anyone looked at this in terms of a systematic pattern?
Irwin: I haven't looked at that. I'm not aware of anything off the top of my head. But certainly, politically it seems to be a lot more difficult. Much more salient as an issue when unemployment is higher and when there's a lot of economic distress.
Beckworth: Yeah. I mean we go back, for example, the 1992 Presidential election with Ross Perot, this was a big deal back then. It seems we had just come off the recession then. Maybe I'm drawing too much out of this, but it does seem to be that this issue is more susceptible to these types of impulses whenever there's economic distress.
Irwin: Absolutely. As you know, the recession in the early 1980s was a very severe one, and there was a lot of protections pressure then. We also had a recession in the early 1970s coming off the gloomy 1960s, and there was a lot of pressure for protectionism in the early 1970s. So you go back, obviously the Great Depression is one. But you can go back further. Early 1890s, same thing. A recession in the United States, a lot of pressure for import duties.
Beckworth: Okay. Well, let's flesh out this argument for trade a little bit more. It's common to hear people say, economists in particular say that we should compensate the losers from trade. So as a whole a nation is better off because of trade. There's higher income because of specialization and all the efficiency gains we get. But there'll be some losers and we should compensate them. How do we do that in practice?
Compensating ‘Losers’ from Trade?
Irwin: Well, first thing I would point out is sometimes we don't want to compensate losers through changes in trade policy.
Irwin: For example, when we're taking away protection, let's say we reach a trade agreement to reduce our sugar quotas. Sugar barons in Florida and elsewhere who are earning rents at the expense of American consumers, I don't think they should get much sympathy. They're incomes have been higher because of trade protection. It's not necessarily would feel that we would want to compensate. That we might have to as part of the political deal, but sometimes when we're taking away trade barriers, we're helping out consumers and others and compensation may not be desirable.
Irwin: But that said, usually when there are trade shocks, and there's going to be political resistance, that you do want to help those ... Particularly workers, not necessarily capital owners, who are going to be harmed as a result of that and have to make transitions to new jobs. The way we've done it, at least in the United States, is we have something known as trade adjustment assistance, which is extended unemployment compensation for those workers who have been certified by the Department of Labor as having been laid off or having lost their jobs because of imports. That's really an imperfect way of helping out those workers. It's tied to the fact that you have to, well, you can only collect those benefits when you're unemployed. There may be some training assistance, but the evidence on the effectiveness of those training programs is actually pretty bad. In other words, we don't do compensation very well. That's been a political problem and an economic problem. There's really no great way in which society or government can provide that compensation.
Irwin: The best way, I think, is through the earned income tax credit. I argued that in the Foreign Affairs piece. That's a much broader approach towards work, facilitates transitions, but even that's imperfect too. I'd say this is not the Achilles heel of free trade, but it's been a perineal problem, is that there's no real ideal way of helping out those workers who are adversely affected.
Beckworth: That income tax credit approach would also speak to those workers displaced from technological shocks as well, correct? I mean-
Irwin: Yes. It doesn't make that distinction, you don't have to be certified or anything.
Irwin: That raises the broader question, do we care why someone loses a job as opposed to, well, they've lost their job and how do we want to help them? If you lose your job because of technology, should you get a different package than if you lose your job because of imports? Can we really make that distinction? It seems to me we need a blanket, uniform policy rather than trying to say, "Well, if you're displaced because of this reason, you get this package. If you're displaced for that reason, then you get something else."
Beckworth: Right. Well, I'm guessing the reason we have a special program for trade is because it's such a politically hot topic. Right? That it's easier to look at technology and say, "Hey, that's a machine. That's a robot. Nothing we can do about that." But when it's a foreigner, we have to do something. Maybe it's just a political solution more than an economic one.
Irwin: It is. It was first introduced in the Kennedy Administration, when they were trying to get permission from congress to undertake a new negotiating round with foreign trade partners under the GATT, General Agreement on Tariffs and Trade, and they wanted to get the support of the labor movement in the early 1960s for the Trade Expansion Act of 1962. The way they did that is saying, "Well, it will help those workers who are harmed as a result of imports." That's the origin of the TEA Program.
Beckworth: Is that program highly utilized? People who are adversely affected, do they take advantage of it?
Irwin: Not as much as you might expect. That's because there are hurdles to getting certified. Once again, it just extends your unemployment compensation. It doesn't really give you many extra benefits necessarily. It's been underutilized as a resource.
Beckworth: How about the retraining option?
Irwin: Well, what's interesting about that is there have been some independent studies trying to look at the effectiveness of that in terms of helping workers. It turns out the people who don't go through these programs do just as well, if not better, than those who take advantage of those training benefits. The evidence is really pretty bad in terms of how much those government training programs help. That's a very lamentable conclusion.
Irwin: I mean the obvious solution would be your broad compensation retraining, but get these workers back on their feet and they'll do great. But it turns out they don't, so that's a frustration.
Beckworth: Yeah. I used to live in Michigan. I would go to class. I would teach the wonders of free trade, and all the great things of capitalism. Come home, my next door neighbor worked in a factory and it got to the point where his factory would shut down one week a month. I had to hear him and his challenges and then I'd go to classroom and teach how wonderful free trade is. I dealt with this tension trying to reconcile what I was teaching to what I saw next door to me. I asked him, I said, "Have you taken advantage of the opportunities to be retrained? The federal government funding." He hadn't. He wasn't even aware of it. That one little anecdotal little bit of evidence there suggested that maybe some of these people aren't just simply aware of it when they lose their jobs. I don't know. Is that the case, do you ...
Irwin: It could be. Obviously it would be up to either the union or the local Department of Labor officials to make people aware of that sort of thing. But once again, it's not free, it's a costly process to get certified.
Irwin: And so some people might think it's just not worth the effort.
Beckworth: It's not as easy in practice as it is to say in theory, "Let's retool and retrain them." It's a much harder path.
Irwin: Yeah. Once again, people who tend to get laid off say from a textile factory or a steel mill, they're not going to go work for Microsoft or Boeing.
Irwin: It requires a different skillset. You have to wonder, "Well, what are we training them for?" We have to have some idea about that.
Beckworth: Okay. Well, let's move to a paper that's made something of a splash. Actually, several papers by the authors, Autor, Dorn and Hanson. They had, I believe, two papers that looked at the effect of China. They showed some pretty dramatic results that some people have taken to be seen as raising maybe the hurdle for trade as a net good. Can you speak as to what the paper has shown and maybe speak to what it hasn't shown in terms of the interpretation by many observers?
Displacement Effects from China Import Shock
Irwin: Sure. I guess our most famous paper's called, “The China Syndrome.” It was published in The American Economic Review a couple of years ago. It generated a lot of discussion among economists and journalists and others because it came up with two findings, at least my view.
Irwin: One is that a large number of workers were really affected by the surge in imports coming from China between, say, 1990 and 2010 or 2007. Although a lot of the surge really happens and occurs between 2000-2007. So a large number of workers displaced. Perhaps many more than economists had expected or anticipated going through that period.
Irwin: And second of all, these workers tended to drop out of labor force or go on to government programs early, disability or social security, taking early retirement or what have you. They didn't transition to new jobs in the labor market. They dropped out of the labor market and went on that, payments. How many showed the numbers and the lack of transition really highlighted to economists in a way that we really hadn't considered so much before. I'd say we'd have to go back to the early 1980s, late 1970s, when people were looking at displaced workers in steel in Pennsylvania and Ohio, to really find these big effects. That came as a surprise and has generated a lot of discussion.
Beckworth: The big contribution they made is just showing the magnitude of the shock, how many jobs were lost?
Irwin: Right. Yep. And of course, what was happening to those workers after they lost their jobs.
Beckworth: What's the flip side of that though? Were there not also many jobs being created in other sectors?
Irwin: Yeah. Here's where our earlier point we were talking about in terms of whether the economy's growing in a robust way or not really matters. The 1990s, the economy was doing quite well. We had an unemployment rate of less than 4% by the end of the 1990s. Obviously some people say, "Well, it was due to the internet bubble," or what have you. But productivity and growth was very rapid, manufacturing output was still rising. That transition, one reason people didn't really notice the China shock in the 1990s, is because the economy was doing so well. So when you had that nice backdrop of a good macro economy, it makes trade adjustment a lot easier.
Irwin: Then the issue comes, "Well, what about the 2000s?" The economy in the 2000s wasn't nearly as good. We weren't creating a lot of new opportunities for blue collar workers. To some extent, this displacement during the 2000s was masked by the housing bubble and the rise in construction employment. There's a paper in the Journal of Economic Perspectives by Erik Hurst and co-authors, talks about this masking this loss.
Irwin: The reason why we're noticing this now is that well, we had this displacement during the 2000s, then we had the financial crisis right after that. The manufacturing jobs have not really come back. The house construction jobs have not come back. And so there's just very many fewer opportunities for blue collar workers. So that lag, I think, explains a little bit of what's going on with the domestic politics and trade at the moment.
Irwin: We had this period of almost 10 years now, where a lot of workers have been hurting. Not necessarily because of trade, but as an aftermath of the great recession, which made the adjustment to those trade shocks much more difficult.
Beckworth: Yeah. I was surprised to read Paul Krugman. He had some comments on this piece, and Scott Sumner made some similar comments as well. And then what Paul Krugman argued was that, "This is an interesting study, but really, it's taking a cross-sectional approach and trying to add them up to get kind of a general approach or a general equilibrium approach was inappropriate." In a sense that they did a great job identifying local regional costs from the China shock, but you can't just aggregate up from those local regional estimates because the very thing you mention is that there's at full employment, as long as the economy's running at full employment, the Fed's doing its job, fiscal policy's doing its job, there's going to be some offset somewhere else that's going to create a fair number of jobs. Only when the economy's weak that this becomes more of a thorn in our sides, as you mentioned.
Irwin: Yeah. I mean but at the same time, I wouldn't criticize Autor, Dorn and Hanson for this. That's not really the point of the research. The point was we had this import shock.
Irwin: I should make an important point about that shock. It’s a one-off shock. Particularly from 2000-2010, when imports from China went from 1% GDP to 2.6% GDP. Since 2011, imports as a share of GDP from China have been flat. It's not like this is actually rising, we're going to lose another few million jobs or something from imports from China. This is a one off thing where China was really achieving its potential in terms of exports of manufacturing goods.
Irwin: Now, as people have noticed or commented on, the working age population in China's beginning to shrink. It could be this shock is receding in some sense.
Irwin: The other interesting thing about the 2000s period is China had an enormous credit count surplus that reached 10% of GDP, which is really unheard of for a large developing country. That's where you get into the issue of currency manipulation. Their foreign exchange reserves ballooned from 300 million to more than 3 trillion, in just a few years. But there were a lot of other macroeconomic things going on that made the China shock in the 2000s special. But one again, it is history now. It's behind us. It's not like it's going to be repeated.
Beckworth: Okay. Does this shock compare, in a historical sense, to what the U.S. economy experienced during late 1800s? I mean would it be a similar event? We're talking about China now, but back then there was this massive transformation from the agricultural-based economy to industrial one. Both of these were supply shocks. Right? You can think of both of these as massive supply shocks to the economy. Maybe one time big supply shocks. I guess my point is, we have had big dislocations before, it's just that this time we're doing a better job of maybe measuring the actual cost of how big they are.
Irwin: Well, when we go back to the late 19th century, we really didn't have any import shocks. We had some export shocks because as transportation costs were going down, we started exporting a lot more wheat. Then you've got the backlash in Europe from American exports of wheat. We also had an export shock in terms of our iron and steel exports. It went up in the 1890s when we discovered a lot of iron ore in Minnesota.
Irwin: But we weren't really subjected to import shocks. The most recent one, I would say, was Japan in the early 1980s. But once again, there was a very rapid rise in imports as a share of GDP, coming from Japan. We saw similarly a lot of angst about Japan and a lot of protectionist measures levied against their exports. That shock was actually much smaller than the China shock, which was really quite large.
Beckworth: Yeah. I guess my point is the China shock is really just one kind of a supply shock. Right? It's a big labor supply shock. But we've had ... I guess this goes back to our earlier conversation, and we have technological shocks, we've got trade shocks, but they all ultimately affect the productive capacity of an economy and they all cause their own disruptions. It's just easier to point a finger at trade because it's foreigners as opposed to a finger at some kind of technological transformation like going from agricultural based economy to more heavily industrialized one.
Beckworth: I mean back in the late 1800s, we had the farmers pro ... The agrarian protests. There's a lot of labor movements back then as well as the transformation took place.
Irwin: Absolutely. You're absolutely right. Introduction of the automobile, electrification, all of these are very disruptive and cause reallocation of labor and capital across industries. They generate a lot of social discontent. So yes, we have been through these things in the past. They haven't necessarily been trade related, but certainly disruptive.
Beckworth: Yeah. Well, let me-
Irwin: With long-term benefits of course, too.
Beckworth: Right. Right.
Measuring the Benefits from Trade with China
Irwin: I mean one thinks that ... I wouldn't criticize Autor, Dorn or Hansen on this, their purpose of their papers was not to look at the benefits of imports of China, they were just focusing on later displacement effects. But on the other hand, there have been benefits from getting cheaper goods from China.
Irwin: There's a study by James Harrigan at University of Virginia, that's in the Review of Economics and Statistics, that looks at what happen when the multi-fiber arrangement ... That expired in 2005. Multi-fiber arrangement was this arrangement that limited the ability of other countries to export clothing to the United States. They found that one year, the price of clothing dropped about 38%. That the gains per household was about $63.00, and obviously this continued over time. So their work in China obviously was exporting a lot more clothing with that expiration of the MFA. There were clear consumer gains as a result of getting rid of that protection for the textile industry.
Beckworth: You raise an interesting question there. You're talking about the benefits from this increased penetration of China into the U.S. market. Are we getting any better at measuring the benefits from trade? The Autor paper seems to do a good job measuring the costs, but how good are we as economists at measuring the benefits?
Irwin: We're getting better. Different people have looked at the different aspects of the gains from trade. My colleague, Nina Pavcnik, has looked at productivity gains from the inability to import a greater variety of intermediate products. Once again, by liberalizing trade in intermediate goods, your final goods producers become much more efficient. You get new industries growing. She's done a lot of work on India, but also Chile. Their gains to variety for consumers, so it's not just industries that benefit from having access to a wider array of inputs but also consumers get a wider array of final goods they can choose from.
Irwin: And Robert Feenstra and others have done a lot of work trying to estimate the gains from variety for consumers. Measuring those gains however, they don't necessarily show up in GDP statistics. It's not like they're easily measured because they tend to be a bit more subtle, but they're real nonetheless.
Beckworth: Okay. One of example of that ... This is anecdotal, but one great story of that is in India, they have a very closed economy, protecting their industries up until the early 1990s. They liberalized. Their main motor company had the same model from the 1950s all the way to the 1990s. Exactly the same car. No innovation. No reduction in price. Once they opened the market, it changed things.
Beckworth: That's one of the key benefits we do see. In the U.S., by opening up our market to foreign competition, to other goods, it improves efficiency and increases income as well. I want to go back-
Irwin: Just on that point, too. Actually, economists are better at identifying the cost of protection from the gains from trade because when you have a protections measure that's put in place, we can observe the price and the quantity effects.
Beckworth: Oh, yep.
Irwin: It provides us a nice counterfactual, it's a change in policy. Whereas if we say, "What's the benefit in trade?" We'll it's compared to what? I mean trade is a process that's ongoing, compared to stopping trade, comparing to imposing tariff, really need a counterfactual to really get a handle on what was the number that people want in terms of how much we benefit from trade.
Beckworth: That's what makes it tough, right, to sell trade because you've got to sell a counterfactual.
Irwin: That's why actually Donald Trump may be a help here because he says, "Okay. We want to impose 35% tariffs against Mexico or China or what have you." Well, that's actually a policy that we can look at in terms of cost and benefits and look at prices and quantities of what might happen. Then find costs to do it, so do it.
Beckworth: Yeah. In fact, I want to jump ahead to a point I was going to raise later, but I think it's a good time to bring it up. Ha-Joon Chang of Cambridge University has made a name for himself by arguing in a few books against the Washington consensus in particular, free trade, by making the case that many of the advanced economies today, the U.S. included, did not go full fledged open market free trade all the time. You responded to that by speaking to this very thing about, "He's not considering the counterfactual." Can you speak to that?
Irwin: Sure. He's written a number of articles and books on this topic and he basically says, "Well, when you look at all the rich countries today, there are all countries, they didn't pursue free trade back in the day. They had interventionist government policies. They protected industries and they did quite well as a result of that."
Irwin: Obviously I'm a great fan of doing trade policy history and what have you, but unfortunately his work is extremely superficial in this regard. It's not simplistic. Literally, it doesn't go much deeper than what I just said. Some rich countries protected in the past, they're rich today, and therefore they're rich because of those policies. What he ignores of course is, A, they're counterfactual. Were those trade policies responsible for that rose in high income achieved by these countries? And second of all, maybe there are other things going on.
Irwin: The U.S. always had a very large, domestic market. We had a lot of domestic competition. We had a relatively small government. It was a stable political environment for investment. We had a pretty high literacy rate in the United States. The property rights were secure. So maybe it was we were going to be rich anyway regardless of what policy we had regarding import industries. He doesn't really control for these other things when he's looking at these comparisons, and so he's very selective in terms of his evidence, which is why I think it's not very persuasive.
Beckworth: Yeah. I'm going to quote. You wrote in an article you reviewed one of his books. "He fails to recognize in the case of the U.S., that the U.S. was already wealthy, had high literacy rates, wildly distributed land, stable government, competitive political institutions, the guaranteed property rights, the large internal market that you just mentioned." These are all these deep institutions that ultimately drive economic growth. He's looking at just this import protection as something that happened to occur.
Beckworth: So he's confusing correlation for causation. You argue that those are the deep things that matter. Those deep institutions. So I guess the follow-up question would be then, how consequential is trade for developing economies? Is trade more of a symptom of these deeper institutions that they do have it, or does it by itself make a big difference?
How Important is Trade for Developing Economies?
Irwin: Well, really it depends on country size, United States was a continental sized market. We were a single market. Single currency. Lot of labor ability. Free internal trade. A lot of people suggested that regardless of our trade policy we still would've done very well as a nation because large countries don't need trade nearly as much as small countries do. But if you're a Netherlands or Belgium or a small island in the Caribbean or a small country in Latin America, you really, trade is going to be much more important for that economy. And getting your trade policy right is going to be much more significant in terms of your future growth path.
Beckworth: Okay. Well let's look to the U.S., because your new book that's coming out, “The Battle Over U.S. Trade Policy,” I looked up the outline, which you have online and it looks very interesting. There's some interesting episodes that I just want to touch on with you if we can for a few minutes here. Let's go back to the early part of our country's history here. You have a chapter called, Trade Policy for a New Nation. Let's talk briefly about President Jefferson's embargo of 1807. Tell us the context of that, that trade issue.
Irwin: Right. The context of that is we were fairly open to trade. Britain and France were fighting tooth and nail against one another. The Napoleonic Wars were going on. They're trying to strangle each other's economy. So the British had a naval blockade of France. France was trying to honestly fight back against the British navy, the royal navy. America is a neutral power, got caught up in this. We wanted to ship to both countries. We said that, "Free. We should be able to ship to wherever we want. Trade with whoever we want." But the royal navy was intercepting our ships to France and elsewhere. That caused political problems here. They would confiscate our cargoes. Some of the sailors saying they're really British citizens, not American citizens. They're very loose on this.
Irwin: President Jefferson said, "How do we respond to this?" We really weren't a military strong nation. We couldn't really fight back. We didn't have a navy to protect our own shipping. So either we had to tolerate this or he got the idea that, "Well, what if we just withheld all ships from the seas?" We would save our sailors and our cargoes from being confiscated and we'd have the economic leverage to force Britain and France to change their policies because they're so dependent on us for agricultural goods and other things that they would see the problems with interfering with our shipping and they'd leave us alone and respect our ships after we denied them our products.
Irwin: And so in December 1808, he asked congress for basically an embargo. Not allowing American ships to travel to British or French or other foreign ports. It really cut off U.S. trade for a little over a year.
Irwin: Talk about a very sharp ... These are the experiments we social scientists love.
Irwin: Big changes in policy. They take effect immediately. Big shock to the system. You can trace through, once again, the price and the quantities and see what the impact is on the U.S. economy.
Beckworth: What did it do to the New England shipping business?
Irwin: Oh, well, it was devastating. Obviously a merchant marine was locked in port. We could observe monthly import and export prices. So the prices of all of our export crops, which at that time were cotton and tobacco, largely, they just dropped immediately by 20% or 30%.
Irwin: Remained low for some period of time. Import prices, because we were dependent on imported manufactured goods, they rose slowly in early 1808, because we allowed American ships that were still out on the seas or in European ports to come back. But within six months or so, those prices had risen about 30% as well. So big price impacts. Trade basically ground to a halt. It led to a lot of political problems for the Jefferson administration.
Irwin: First of all, there was a lot of smuggling going on. Obviously you're creating price differential between markets and people want to get their goods out and make money the way they had previously done. So Jefferson administration had to keep ratcheting up the enforcement of the embargo.
Irwin: And second of all, it became very political unpopular in New England in particular, where we were dependent on our shipping industry, ship building industry, whale oil exports, things of that sort. And so even Jeffersonian Republicans from New England started questioning whether this embargo was a good idea or not. In fact, there was even discussion that New England might secede from the country if this had continued. So the political pressure really built on the Jefferson administration and eventually congress repealed it in early 1809. And then you'd see prices snapping right back and shipping volumes snapping back.
Irwin: Not fully, but to a large measure and Chung identified the welfare impact on that. I did one calculation where I thought that the embargo cost us about 5% or 6% of GDP from welfare losses, which is quite a bit in one year.
Beckworth: Wow. Well, that's interesting. I didn't realize New England had talked about seceding from the nation because of that. But it makes sense. It's completely reasonable given that the harshness of it.
Irwin: Yeah. And-
Beckworth: Soon after ... Go ahead.
Irwin: And later, there was another instance, the U.S., a region of the country thought about seceding. That was the South Carolina during the Tariff of Abominations in the late 1820s. Where once again, tariffs were raised to very high levels. The south was the export platform for the United States. They thought, "Well, we just don't have enough political power to change policy, so we're just going to have to leave the country." I don't know how serious they were, but there was certainly talk about that.
Beckworth: Now, that's interesting too. I was going to get to that. Let's talk about that. So that all the tariffs up until 1816 had been ones for fighting the war, send a message to England or to United Kingdom and France. But the Tariff of 1816 was really the first tariff for protectionist reasons, as I understand. After that point, there is this tension between the north and the south over these trade policies.
Beckworth: The north wanted domestic protection for their industries. The south thought it was hurting them both, their exports as well as their imports. And created this tension. As you mentioned, the Tariff of Abominations, 1828, that's a high point for tariff rates in the U.S., is that correct?
Irwin: It is. The average tariff on dutiable imports is 62%, which is the highest in U.S. history.
Irwin: And it was even higher than that reached under the Smoot-Hawley Tariff in the early 1930s. Once again, you had this sort of ... Think about congressional voting in a very sexual way. New England had now had a textile industry, which was competing against Britain. The middle Atlantic states like Pennsylvania, had ironworks, glassworks, which were also competing against Britain. So both New England and mid-Atlantic states wanted high tariffs, and the south was where a lot of the U.S. exports came from. Cotton, tobacco, rice and things of that sort, so the south wanted low tariffs and freer trade.
Irwin: Because the south was getting outvoted in congress, the final straw in some sense was the Tariff of Abominations, 1828. Shortly thereafter, South Carolina had something known as the Nullification Proclamation, which said that, "We're just not going to enforce the tariff in South Carolina courts," which led to an actual crisis. President Andrew Jackson said, "Nope. That cannot be. The national government rules over the states." They reached a compromise in 1833, but it was touch and go for a while in terms of how the country would work out there.
Beckworth: This trade issue between the north and south continues all the way up to the Civil War. Correct?
Irwin: Yeah, even after the Civil War. One of the things I show, actually in the introduction of the book, is I have a chart of congressional voting on, I think it's the Tariff of Abominations in 1828, and then congressional voting on the Smoot-Hawley Tariff in 1929 in the House of Representatives. The correlation in the state voting is 0.7. If you were to overlay those two, it would be very hard to tell the difference. There's a very stark north/south divide over trade policy.
Irwin: I guess the major theme of the book will be, "We think trade policy's controversial today, it's always been controversial." There's always been political conflict over trade policy. In some sense, the post-World War II consensus in favor of more open trade from say the 1950s until maybe the 1970s or 1980s when trade once again came back as a political issue. That's really the exception in U.S. history.
Irwin: The normal movement of events is there's going to be two parties. They're going to disagree about trade policy quite a bit, and there's going to be a lot of political conflict in congress about what trade policy should be.
Beckworth: Donald Trump really wants to get us back to our trend, huh? He wants to take us back to the way it used to be.
Irwin: I think he's just a manifestation of the fact that we're no longer in this bipartisan consensus on trade anymore.
Beckworth: I guess so. Wow.
Irwin: This is something James Madison, in Federalist 10, explicitly said. He said, "Our country is going to be formed of a different interest. They're going to disagree on legislation and they're going to have to fight it out in Congress and there's no reason to think that there's always going to be a consensus." He explicitly pointed to whether a manufacturing industry should be protected from foreign competition as being one of the major divides within any democratic nation.
Beckworth: Yep. Just to be clear, in going back to the point you made earlier, just because U.S. did have these high tariff rates, does not mean they were the cause of its rapid economic development. As you mentioned earlier, the U.S. may have grown even faster had these high tariffs not been in place.
Irwin: Yeah. I have sections of the book talking about infant industries and talking about whether U.S. industrialized because of the tariff. It's not really the case. The cotton textile industry did quite well in pre-Civil War period. Especially after 1833, when tariffs on imported textiles had actually been cut to relatively low levels. There's a lot going on in the U.S., once again, in just trade policy and determining whether we're going to be an industrial country or not. We had a lot of natural resources. The iron and steel industry grew because we had huge iron ore deposits. We had a lot of coal.
Irwin: Actually, we think we were protectionist country in the 19th century, but actually we were very open to the international economy. We had free technology. Well, not free technology, but the tech, we had very close commercial and cultural ties to Britain, which was home of the industrial revolution where a lot of new technology was being invested and refined. We had access to that technology. The technology came to the U.S. very quickly. It could be adapted to local conditions.
Irwin: We had free open, international capital markets and we also had basically free immigration. So while we did have tariffs on goods, we had a lot of trade in ideas, a lot of trade in people, and a lot of trade in capital that kept us very open and kept competition in the domestic market fairly robust.
Irwin: So there's another area where I think the U.S. experience is very different from developing countries, which tend to have much smaller markets. They tend not to have easy access to the world's best technology. They tend to have small markets, so when you raise tariff barriers, you're protecting relatively small, inefficient producers. In the U.S., even if we had high tariff barriers, we had free entry and a large continental market and access to the best technology. So your frequency costs of those tariffs was much less. Our firms tend to be on the technological frontier and they tend to be very subject to a lot of competitive pressure because of free entry at home.
Beckworth: Okay. Well, I'll look forward to that book coming out. I'm sure our listeners will as well. They'll make sure to get a copy of it.
Beckworth: Let's switch gears now to some of your more recent work on the Great Depression and the gold standard. We had some guests on here talk about it before, but you've done some really interesting work on the role the gold standard played. In particular, the role that France and the U.S. did. Can you give us a quick background on why the gold standard was so important to the Great Depression?
The Great Depression and the Gold Standard
Irwin: Sure. Here, I've basically been a consumer of this literature for some time. Particularly Barry Eichengreen work on “Golden Feathers,” Scott Sumner's work – the Great Depression is just this, what's in this shock that we'll, I think scholars will be studying for generations. It's just endlessly fascinating. How could this possibly happen? This great disaster. Eichengreen, Sumner, a whole bunch of people, Bernanke have written about how the gold standard had hamstrung policy makers, central banks, in terms of their response to the depression. Obviously Freedman Schwartz here are very important in studying the depression as well. The role of monetary forces.
Irwin: I guess how I got into it, looking at Eichengreen's work and others, I see how the Fed tightening in 1928 to kill the stock market bubble, have tipped us into a recession. And how bank failures in the decline of the money multiplier, big declines in the money supply in the United States, but this is obviously a worldwide phenomenon. There's massive deflation during this period.
Irwin: I've always scratched my head about this idea that while the U.S. caused it all, the U.S. tipped the world economy into a depression and everyone sort of just tumbled after the U.S. In other words, what was the shock that caused the world price level to fall by 1/3? Were countries just following the U.S.? Or what was going on?
Irwin: That's where Scott Sumner's work and a particular work by Karp Johnson where he had a book in 1997 on France and the Great Depression, was really eye-opening to me in terms of France's contribution, which I think has been underplayed and under-appreciated.
Irwin: So in 1926, France had about 10% of the world's gold stock, which is about the same as the UK. But by 1932, France had 25% of the world's gold stock. That's just astounding. It's off the charts. Going from 10% world's gold stock, in line with Germany and the UK, to be a huge outlier. So obviously there's something going on in France during this period in terms of the attraction of gold to France.
Irwin: Probably it has to do with the undervaluation with the franc when they went back on the gold standard. But it's even more severe than that because first of all, just because one country has a lot of gold, it doesn't necessarily make it a problem if they're monetizing gold, which is what they're supposed to be doing under the rules of the gold standard. But instead, France was not monetizing the gold they were receiving. There's something called a cover ratio, which is a should be constant in terms of how much currency you have for a gold reserves. But instead, that cover ratio rose astronomically in France as opposed to other countries.
Irwin: So in other words, they're attracting this gold from the rest of the world, but not inflating and monetizing it, which means that the David Hume's price-specie flow mechanism is just not going to work. And so when I do this, some study this and some calculations, and discovered it was really responsible for a lot of the deflation in the world economy during this period. That if France had monetized its gold and this hadn't occurred, the world price level based on how much gold was in the system, would've remained roughly flat from 1929-1933, instead of falling by about 1/3. So it was responsible apparently for a lot of the deflation in this period which of course as you and your listeners might know compounded a lot of things in terms of bank failures, inability of debtors to pay their debts and all sorts of problems like that.
Beckworth: That's amazing that France by itself was a difference between a flat global price level and a price level that declined by 1/3. That's just staggering.
Irwin: Yeah. I think it's actually the combined impact of the U.S. and France, because the U.S. was doing that as well.
Irwin: I think between the U.S. and France ... Well, at least what I'm trying to do in the paper is say, "Yes, U.S. played a role, but France played an equal role, maybe an even slightly larger role." But roughly it's a joint contribution of them. Not just the U.S.
Beckworth: For our listeners who don't understand the price-specie flow mechanism, could you just explain that to them briefly?
Irwin: Sure. If a country receives an inflow of gold from the rest of the world into their central bank, the central bank is supposed to be creating deposits to ... Or increase the money supply or compensate or to account for those gold inflows. What that does is it'll raise domestic prices of the country experiencing gold inflows. They'll have a trade deficit. They'll have to pay for that deficit with gold flowing out and you sort of equilibrate the system that way. So gold reserves are naturally allocated across countries, and it's not just one country, it's holders and providers of the basis for their monetary base or money supply.
Beckworth: It provides a natural equilibrating mechanism across the world in terms of trade deficits. Gold flows out, flows in. Money supplies respond. If central banks, if the countries allow this gold specie flow mechanism to work.
Beckworth: What you show in your papers and what Barry Eichengreen and others have shown is that these countries weren't playing by the rules of the game. They weren't allowing gold and the system to respond appropriately. Barry Eichengreen has said this is the case, as compared to the classical gold standard.
Beckworth: The classical gold standard from late 1870s - 1914 worked relatively well. This mechanism. But Barry Eichengreen argues that there were more enfranchised voters. Democracy got a bigger foothold, and so now citizens, they couldn't tolerate the discipline, maybe the pain of the gold standard in many of these adjustments.
Beckworth: George Selgin, he's been on the show. He argues the gold standard didn't work during the inner work period because central banks were now managing it. But to me, both of these speak to this issue of whether you have internal balance or external balance. And the reason central banks are so dominant during this inner work period is because I think they're just body politic push. Let's do macroeconomic stabilization, which speaks, I think, to the same point Barry Eichengreen making.
Beckworth: Which leads to this last question I have for you, do you think it is possible to ever return to a gold standard in the future?
Irwin: Not really because I think what I think my paper showed and obviously people had appreciated this beforehand as well, is that it's not this autonomous, automatic market mechanism. It's actually being managed by central banks. The supply of gold matters a lot for how countries shape their monetary policies. If we were to go back to a gold standard today, well we'd have to think about how are we going to expand the world gold stock in line with rising productivity. I think most of the world's gold stock now comes from China, Russia, South Africa. These are countries that are not necessarily our friends. I'm not sure we want to put our monetary policy in the hands of these countries in terms of, "Well what if they were to declare an embargo on gold exports? Or start hoarding gold and forcing us to deflate?" Or things of that sort. So it's inherently political and I just think monetary policy autonomy the way frequent envisioned it, is a much better way to go.
Irwin: I think you're absolutely right in terms of the problem with the end of war period was that there was this conflict between internal balance and external balance and countries were just not willing to sacrifice domestic economy just to maintain the exchange rate peg or stay on the gold standard.
Irwin: This paper by Michael Bordeaux and Anna Schwartz, basically I think the title is something like, “Conflicts from an Internal and External Balance Inevitably End Up as Currency Crises”… or “Financial Crises.” So it's just difficult to sustain that.
Beckworth: Yeah. George Selgin has an interesting article he wrote for Cato on this. I think it speaks to many of the gold advocates out there, people who want to return to the gold standard. He says, "Look, if we return to the gold standard, the very institutions you despise, central banks, will be the ones managing the gold standard. And you've got to get all of them on the same page, have a coordinated system. And we see it as very challenging." For some of the reasons you've already outlined. So it would be difficult to have this international fixed exchange rate regime make sense.
Beckworth: I mean the other thing I would note is the Euro zone is kind of a microcosm of that. It's a big economy, many regional economies under one exchange rate, the Euro, which is what the world would be under, under a gold standard. One fixed exchange rate regime. In terms of the literature, we'd say that would not be an optimal currency area.
Irwin: Right. Usually there's pressure or discussion of introducing gold standard whenever you have periods of high inflation because you want to rein in central banks and discipline them in some way. Right now, we have relatively low inflation. There's still worries about deflation in some places. And so it seems like an odd period or an odd time to try to resurrect this idea.
Beckworth: Yep. Well, we are out of time. Our guest today has been Doug Irwin. Doug, thank you for being on the show.
Irwin: Thanks. I enjoyed it very much.